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Shares of Applied Materials (AMAT), the manufacturer of equipment and software for the global semiconductor, display and solar industry, ended the week roughly flat. On Wednesday, the company reported its third quarter results.

Third Quarter Results

Applied Materials reported third quarter revenues of $2.34 billion, down 16% on the year. Revenues were down 8% compared to the second quarter. GAAP operating income fell from $687 million last year, to $322 million. Net income fell from last year's $476 million to $218 million, or $0.17 per share. In comparison, Applied reported second quarter profits of $0.22 per share.

Excluding a $44 million charge, related to the restructuring of the solar business, earnings came in at $0.24 per share. The order book indicates that the worst is not over yet. New orders came in at $1.80 billion, resulting in a $551 million drop in the order book to $1.82 billion.

The acquired Varian activities contributed $294 million in quarterly revenues and booked $241 million in new orders. The contribution to bottom line earnings per share was $0.04.

Applied Material repurchased 46.7 million shares during the quarter, at an average price of $10.71, for a total value of $500 million. Over the past year, the company retired 97 million shares, or 7% of its shares outstanding.

CEO and Chairman Mike Splinter commented on the results, "We delivered solid financial performance in line with our outlook despite challenging industry conditions in semiconductor, display and solar. Economic uncertainty is weighing on top of a seasonal pullback to produce weaker near-term demand."

Segmental Information

Silicon Systems Group

Applied's largest division reported net sales of $1.55 billion, down 13% on the quarter. Orders fell 41% to $1.17 billion, resulting in a book-to-bill ratio of merely 0.75. GAAP-operating income came in at $427 million.

Applied Global Services

The applied global service division reported revenues of $579 million, up 5% on the quarter. Orders fell 18% to $531 million, as the second quarter order intake was really strong as a result of thin film production orders. GAAP-operating income came in at $122 million.

Display Orders

Display orders came in at merely $67 million, down 20% on the quarter. Net sales actually increased 6% to $142 million, resulting in GAAP-operating income of $10 million.

Energy and Environmental Solutions

The troubled division reported orders of a mere $35 million, down 44% on the quarter. Sales fell 3% to $77 million, resulting in a GAAP-operating loss of $102 million, driven by inventory charges.

Outlook

For the fourth quarter of 2012, Applied Materials expects sales to fall 25 to 40% sequentially. This would translate into sales between $1.40-$1.76 billion and compares to analysts estimates of $1.94 billion.

Non-GAAP earnings per share are expected to come in between $0.00 and $0.06, which compares to non-GAAP earnings per share of $0.24 in the third quarter. On average, analysts expected Applied Materials to guide for non-GAAP earnings of $0.12 per share. On GAAP related metrics, the company is expected to lose money.

Valuation

Applied Materials ended its third quarter of 2012 with $3.2 billion in cash, equivalents, short and long term investments. The company operates with approximately $1.9 billion in long term debt, for a net cash position of $1.3 billion.

For the first nine months of the year, the company generated revenues of $7.1 billion, putting the company on track to generate annual revenues of $8.6 billion. Net income came in at $624 million, or $0.48 per share, and most likely will come in around $0.45 per share for the full year.

The market currently values the company at $15.4 billion. Operating assets are valued at $14.1 billion, valuing the firm at 1.6 times annual revenues and roughly 23 times annual earnings. This valuation compares to a revenue multiple of 2.8 times for KLA-Tencor (KLAC) and 1.6 times for Lam Research (LRCX). These competitors trade at 12 and 26 times annual trailing earnings, respectively.

Currently, Applied Materials pays a quarterly dividend of $0.09 per share, for an annual dividend yield of 3.0%.

Investment Thesis

Year to date, shares in Applied Materials have gained roughly 12%. Shares rallied to $13 in February but fell back to $10 by May. Last week they closed at $12 per share.

Over the past five years shares lost about 40% of their value, falling from levels around $20 in 2008. The company's revenues and profits quickly recovered after a dramatic 2009. As a result of a weak third and fourth quarter in 2012, revenue levels for the whole year will fall back to the levels of 2008. At the same time, net income remains incredibly volatile, falling from $1.9 billion for the full year of 2011 to levels around $600 million for 2012.

Investors see few prospects for sustainable value creation. While the business is inherently cyclical, Applied Materials does not succeed in structurally increasing its revenues, or its profit margins. This leads to low growth in "through-the-cycle" earnings and annual dividends.

Unless the company can structurally reduce the cyclicality of the business, or improve operational performance through-the-cycle. I remain on the sidelines.

Source: Applied Materials - Solar Division Is A Drag On Shares